Ethics Case Harding Financial Services Company holds a large portfolio of debt a

Question

Ethics Case Harding Financial Services Company holds a large portfolio of debt and stock securities as an investment. The total fair value of the portfolio at December 31,2017, is greater than total cost. Some securities have increased in value and others have decreased. Ann Bales, the financial vice president, and Kim Beeble, the controller, are in the process of classifying for the first time the securities in the portfolio. Bales suggests classifying the securities that have increased in value as trading securities in order to increase net income for the year. She wants to classify the securities that have decreased in value as long-term available-for-sale securities, so that the decreases in value will not affect 2017 net income. Beeble disagrees. She recommends classifying the securities that have decreased in value as trading securities and those that have increased in value as long-term available-for-sale securities. Beeble argues that the company is having a good earnings year and that recognizing the losses now will help to smooth income for this year. Moreover, for future years, when the company may not be as profitable, the company will have built-in gains. Instructions Will classifying the securities as Bales and Beekble suggest actually affect earnings as each says it will? Is there anything unethical in what Bales and Beable propose? Who are the stakeholders affected by their proposals? Assume that Bales and Beeble properly classify the portfolio. At year-end, Bales proposes to sell the securities that will increase 2017 net income, and Beeble proposes to sell the securities that will decrease 2017 net income. Is this unethical?

Explanation / Answer

a. Yes. Gain on trading trading securities can be recognized in the Income Statement as part of current year net income. On the other unrealized gains or losses on available-for-sale secuties cannot be carried in the Income Statement, rather they are shown as part of Other Comprehensive Income.

b. Yes, it is unethical. The main aim of financil reporting is to convey a true and fair view of the operating results, and the financial position to the stakeholders of the company. What Bales and Reeble intend doing is because of their own agenda of either reporting higher net income to please the stockholders, or lower net income to save on income tax expense.

Either way, it amounts to earnings management, an euphemism for accounting manipulation.

c. Bales proposal is not unethical, as it is compatible with the overall goal of stockholder wealth maximization. But what Reeble suggests is unethical, as it goes against the goal of shareholder wealth maximization, and is aimed at her personal goal of reducing tax expense at the cost of capital erosion of the firm.

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